Stephen A. Rhoades

The efficiency effects of bank mergers: An overview of case studies of nine mergers

Abstract This paper summarizes nine case studies, by nine authors, on the efficiency effects of bank mergers. The mergers selected for study were ones that seemed relatively likely to yield efficiency gains. That is, they involved relatively large banks generally with substantial market overlap, and most occurred during the early 1990s when efficiency was getting a lot of attention in banking. All nine of the mergers resulted in significant cost cutting in line with premerger projections. Four of the nine mergers were clearly successful in improving cost efficiency but five were not. It is not possible to isolate specific factors from these mergers that are most likely to yield efficiency gains, but the most frequent and serious problem was unexpected difficulty in integrating data processing systems and operations.

Efficiency effects of horizontal (in-market) bank mergers

Abstract This study conducts tests to determine whether banks involved in horizontal mergers achieve efficiency improvements relative to other firms. The analysis covers 898 bank mergers from 1981 to 1986. Efficiency is measured by various expense ratios. The results based on OLS and logit analysis are robust. They indicate that during 1981–1986, horizontal bank mergers did not yield efficiency gains. Notably, the findings are based on the mergers believed to be most likely to result in efficiency gains, i.e., they are horizontal mergers, the firms exhibit considerable deposit overlap, and the acquiring firms are, on average, more efficient than the acquired.

Acquisition Targets and Motives: The Case of the Banking Industry

Findings do not indicate poorly-managed firms are more likely to be acquired than well-managed firms. The analysis uses a sample of 1,046Texas banks that existed in 1970, out of which 201 were acqui red during the period 1970-82. A multinomial logit procedure is used to estimate the relationship between the likelihood of acquisition and the characteristics of the target firm and its market. Additional results suggest that firms with la rge market shares, low capital/asset ratios, and operations in urban areas are r elatively likely to be acquired but not firms with low profits or low growth. Copyright 1987 by MIT Press.

Strategic groups in banking

The strategic groups hypothesis is tested using cluster analysis in -16 selected banking markets and based on portfolio composition in 1978, 1981, and 1984. The results indicate that approximately six strategic groups exist in banking and are stable over time. Strategy choices are similar across markets. Implications of the results are (1) intraindustry profit differences may be due to strategic groups rather than efficiency differences, (2) markets may generally be defined too broadly, (3) investigations for collusion need to focus on homogeneous groups in an industry rather than the whole industry, and (4) there is no simple strategy choice for banks between retail and wholesale banking.

Market share as a source of market power: Implications and some evidence

Abstract This paper investigates the proposition that firms with a high market share enjoy a unique form of market power—“inherent product differentiation.” The analysis is based on a sample of 6492 banks, during the 1970s. Tests tend to control for market concentration, scale economies, and explicit product differentiation as factors influencing rates of return. Test results indicate that market share per se is a source of high profits, regardless of the level of concentration and after controlling for firm size. These findings question the Demsetz (1973) view that high profits of market leaders are due to efficiency rather than to some form of market power. These findings suggest that traditional market models that account only for a single price may be incomplete. The paper suggests a kind of simple model that would account for the existence of multiple prices in a market.

Market Share Inequality, the HHI, and Other Measures of the Firm-Composition of a Market

Data for individual markets suggest that the Herfindahl- Hirschman Index does not fully account for the inequality of market shares and the number of firms in a market. An empirical investigation is conducted to determine whether share inequality, number of firms, and major firm presence affect market profit rates independent of the HHI. The analysis controls for efficiency, among other things. Test results based on 1,684 banking markets during 1990–1992 indicate that the HHI, market share inequality, and the importance of major firms are positively related and the number of firms is negatively related to profit rates. Results on several other variables also suggest that market imperfections exist in local banking markets.

Structure and Profitability in Banking Markets

We use the structure-performance model and regression analysis to investigate a number of analytical issues that often arise in evaluating competition in connection with bank mergers and that are generally relevant to mergers in other industries. Perhaps our most consistent and strongest finding is that the local market HHI is positively and significantly related to profitability. We also find that the number of organizations and the level of recent deposit growth may provide some additional information on the level of competition. Finally, several variables including market size, the number of large banking firms, deposits per office, and resident migration rates exhibit similar relationships to profitability in the bivariate analysis, suggesting that there may be some characteristic associated with market size, density, or attractiveness that is important for competition.

Geographic diversification and risk in banking

Abstract Tests of the hypothesis that geographic diversification affects bank risk are conducted on large samples of banking organizations (1976–1985) and focus on intrastate geographic diversification experience. Three composite measures of risk are included iin the tests along with the individual components of these measures. Results show that while composite measures of risk are reduced by geographic diverisification, some inidividual components of these measures increase. Importantly, the results show lower financial risk (the variation in earnings), which is predicted by portfolio theory. However, we also observe lower levels of earnings and capital with greater diversification implying, ceteris paribus, higher risk. This effect is not predicted by portfolio theory, but is predicted by our notion of operating risk. There is apparently more than pure financial risk involved with diversification by firms.

Determinants of premiums paid in bank acquisitions

Summary and ConclusionsMergers are a relatively observable form of business behavior and reflect a major business decision. As such, mergers provide an attractive opportunity for empirical investigation into business behavior, which may shed light on business motivation. This study tests for the determinants of premiums paid in 1,835 of the 2,717 bank mergers and acquisitions that occurred from 1973–83.The only variables that are often statistically significant and carry consistent sights are: (1) growth of the target firm; (2) growth of the target market; and (3) the capital-to-assets ratio of the target firm. The signs on these variables suggest that high growth of the target firm and its market and a low capital-to-assets ratio are particularly attractive to bank managers, for which they are willing to pay a premium. Variables which provide a relatively direct indication of profit opportunities are often not statistically significant or carry mixed signs.Overall, the results suggest that, among the set of banks that are actually acquired, growth of the target bank and its market will induce bank managers to pay a premium but profits of the target do not elicit a premium.

Asset diversification, firm risk, and risk-based capital requirements in banking

The implications of diversification by firms for risk has been raised particularly in connection with conglomerate mergers. This issue is of special interest in banking now because of a recently implemented policy — risk-based capital guidelines. This study presents results of an empirical investigation into the relationship between diversification of a banks financial assets and indicators of the risk of insolvency. Results indicate that financial asset diversification, as well as geographic diversification, are related to lower risk.